The banking sector is still dealing with fallout from the 2009 economic crisis, but banks are slowly reducing their bad debt ratios thanks to new requirements set out by the central bank and due to come into effect next year.
A recent note by ratings agency Moody’s said that Dubai’s banks were still carrying a high percentage of inactive loans on their books and that the slow rate of economic recovery would maintain pressure on earnings for this year and the next.
Moody’s maintained its negative outlook for banks in Dubai and the rest of the UAE, largely due to issues relating to asset quality that are linked to the restructuring of corporate agencies and government-related entities. The ratings agency cited Dubai World, which has restructured some $25bn worth of debt, as an example.
“We expect profitability to remain constrained by cautious loan growth and the ongoing provisioning that is required to cover elevated problem loan levels, against a background of mixed signs of a recovery and our expectation that the performance of UAE banks’ net earnings will remain uneven over the coming 12-18 months,” Moody’s wrote in the report, issued in early November.
More positive was Moody’s forecast for banks’ non-performing loans (NPLs). Khalid Ferdous Howladar, a vice-president with the agency, said that the ratios of such debts would start to ease in 2012, after peaking at around the 15-17% range this year, above the UAE average of 10-12%.
“While the peak will be largely driven by the culmination of impairments by government-related issuers and legacy real estate exposures, we expect a slight easing of asset-quality pressure in 2013,” he said.
Dubai’s banks will come under pressure of a different kind next year when new central bank regulations come into force that aim to raise liquidity requirements and keep them in line with the Basel III standards. This new set of standards has set out that banks must hold at least 10% of assets in highly liquid instruments, mandates stress-test levels and risk-management provisions, and restricts the future ratios of NPLs.
While most – if not all – of Dubai’s banks are expected to be able to comply with the new rules when they come into effect, the higher liquidity requirements could reduce lending and cut into banks’ profits, at least in the short term.
Another new regulation introduced by the central bank at the end of September that limits banks in their lending to local government agencies and state-related bodies is aimed at bolstering risk management. Under the new requirements, unveiled in April, lending by local banks to governments and their commercial holding companies is capped at 100% of their capital, and lending to any single entity or government is restricted to 25%.
The central bank’s measures intended to better regulate the sector have generally been welcomed by the industry. “Dubai has seen a significant growth in capital adequacy ratios (CAR),” Peter Baltussen, the CEO of Commercial Bank of Dubai, told OBG. “Between 2008 and 2012 the CAR of banks in Dubai have risen to between 15% and 20%, indicating the regulators’ commitment to conservative minimum requirements.”
However, there are concerns that the deadlines for compliance are too tight. In mid-October, Hussain Al Qemzi, the CEO of Dubai-based Noor Islamic Bank, said it could take up to three years for some lenders to meet the reserve’s requirements on lending to governments and their commercial holding companies, particularly those with high exposure to state entities.
“I think time is required,” Al Qemzi told English-language daily The National. “Time is very important, whatever you want to do. We are just getting out of the crisis, and we are watching levels of liquidity heading up.”
It is estimated that the Dubai government and state-related firms have about $15bn worth of debt reduction due this year. If the central bank’s regulations are strictly adhered to, local banks may well be shut out of any rolling over of the loans.
Though it may take some time for Dubai’s banks to lose the negative tag they currently hold, continued progress in lowering NPL ratios and in meeting the Basel III requirements will boost confidence, while also reducing vulnerability to external shock.